What is an engulfing candlestick? There are two types: the bullish engulfing, and the bearish engulfing candle. A bullish engulfing candle can indicate a change in momentum to the upside. The opposite is true for a bearish engulfing candle. The pattern is made up of 2 candlesticks, where the most recent candle's body fully engulfs the body of the previous candle.
Here's What They Look Like
NOTE: Keep in mind that with engulfing candles, we are not concerned with the wicks of the candles. As long as the body engulfs the previous body, it is considered an engulfing candle. However, it may be even stronger of a candle if it engulfs the wicks too.
How to Trade This Candlestick Pattern
Engulfing candles usually show up at the end of a trend to signal a reversal. The way we like to trade them is to spot them in short term counter-trends, in anticipation of a continuation of the overall trend.
So, what do we mean by this? Essentially, if a stock is in an uptrend, at one point it is bound to dip to a support level and then continue higher. We look for the short-term dip followed by an bullish engulfing candle to signal that the longer term trend is about to resume. If we're short selling, then we look for a bounce in price followed by a bearish engulfing candle which will signal more bearishness.
Examples of this below:
Engulfing candles can also be used as an indicator to get you out of a position that you are in. If you look at Macy's chart (posted right above this paragraph), you'll see the large bearish engulfing candle pointed out. If you were in a long position prior, then that candle would surely signal you to close your position. Engulfing candles are even more powerful if they are accompanied by high relative volume on that day.
Where to Place Stop Losses
Generally, you should have your stop a bit under the bullish engulfing candle if you are long and vice versa if you are short selling. You can also put your stop loss under the swing low (if you're long) or the swing high (if you're short).
Example of this below:
Identifying Support/Resistance Spots
Support and resistance levels can be found using moving averages, horizontal supports, and trend lines. The moving averages we use are the 9 EMA, 20 EMA, and 50 SMA. An engulfing candle at the moving averages is a good entry assuming it is in the same direction of the overall trend. Learn more about one of the ways we use moving averages with this swing trading strategy.
Where to Take Profits
We won't go into too much depth here as there are many ways to set price targets, but your target with this strategy is generally going to be the high (if you're long) or low (if you're short) of the previous swing, or you can take profits when new highs/lows are made. You can also draw trend lines or horizontal support/resistance points and take profits there, or use a trailing stop loss.
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